Higher interest rates increase debt-servicing costs for household and business borrowers. This increases the likelihood that they will default on loans, which in turn increases credit risks for lenders. This is the main channel through which households and businesses can affect financial stability.
Since the global financial crisis, nearly all of the £425 billion net increase in UK corporate debt has come from MBF (Chart A).
Chart A: Composition of UK aggregate corporate debt split by bank loans and MBF (a)
Footnotes
- Sources: Association of British Insurers, Bank of England, Bayes CRE Lending Report (Bayes Business School (formerly Cass), Deloitte, Eikon from Refinitiv, Financing & Leasing Association, firm public disclosures, Integer Advisors estimates, LCD an offering of S&P Global Market Intelligence, London Stock Exchange, ONS, Peer-to-Peer Finance Association and Bank calculations.
- (a) These data are for private non-financial corporations (PNFCs), which exclude public, financial and unincorporated businesses.
MBF can, in theory, help provide diversification of funding sources and increase the resilience of the supply of finance to corporates. But it can also introduce additional vulnerabilities (eg the crystallisation of risks in MBF could amplify economic shocks and disrupt the provision of financial services to UK corporates). This makes it vital for the Financial Policy Committee to continue to identify vulnerabilities and seek to mitigate those risks.
UK corporates have been experiencing headwinds from higher interest rates and the subdued macroeconomic backdrop. Consequently, riskier borrowers seeking MBF had experienced a more subdued appetite from investors, with the primary market for high-yield bonds closed in parts of 2022. Over 2022, where parts of the market were shut, around 8% of high-yield bonds fell due, although these issuers had recourse to other sources of credit such as revolving credit facilities or deleveraging. Furthermore, there were no new leveraged loan issuances in 2022 from firms with more than six times debt to earnings before interest, tax, depreciation and amortisation.
Bank staff use non-bank deal-level data to examine corporate refinancing risk by issuer credit grade. The near-term refinancing risk appears relatively limited. Corporates tend to refinance their debt around 12–18 months before it comes due. So, we look at both the amount of debt due for refinancing this year (6% for corporate bonds and leveraged loans combined) and cumulatively by the end of 2025 (22%) (Chart B). Both are well within year-on-year typical ranges.
Chart B: Refinancing risk scaled to bond and leveraged loan debt using available deal-level sample (a) (b)
Footnotes
- Sources: Bloomberg for leveraged loans, Eikon from Refinitiv for bonds and Bank calculations.
- (a) The deal-level sample includes UK PNFC issuers of Investment grade bonds, High yield bonds and Leveraged loans, with riskier credit defined by High yield bonds and Leveraged loans.
- (b) Within the UK PNFC debt stock coming from MBF, bonds account for the largest share by some margin. The remainder of MBF comprises leveraged loans, commercial paper, private credit, direct lending from insurers and security dealers and finance leasing.
However, it is not typical for riskier corporates to be able to switch lending markets. For example, non-investment grade issuers cannot easily access the investment-grade bond markets. This exposes corporates in riskier credit markets such as leveraged loans, private credit and high-yield bonds to greater risks. Around 2% of leveraged lending is coming up for refinancing this year, this compares to 30% by end 2025 (Chart C).
Chart C: Refinancing risk from MBF scaled within specific market segments using our deal-level sample (a) (b) (c) (d) (e)
Footnotes
- Sources: Bloomberg for leveraged loans, Eikon from Refinitiv for bonds and Bank calculations.
- (a) The deal-level sample includes UK PNFC issuers of investment-grade bonds, high-yield bonds and leveraged loans, with riskier credit defined by high-yield bonds and leveraged loans.
- (b) Investment-grade bonds have a rating of BBB and above.
- (c) High-yield bonds are rated below BBB.
- (d) Leveraged loans are defined as the borrower having a debt to earnings before interest and taxes (EBIT) ratio of 4.5 or above and/or a private equity sponsor. EBIT measures a company’s net income before income tax and interest expenses are deducted.
- (e) Other types of market-based finance not shown in the chart are private credit, direct lending funds, loans from insures and security dealers and finance leasing.
The maturity profile of the debt impacts the rate at which corporates are exposed to higher interest rates, and the extent to which refinancing pressures could pose risks to financial stability. The corporates that do not have near-term refinancing requirements have latitude to adjust their balance sheets to the higher interest rate environment. Nonetheless, the highly leveraged firms are likely to experience more pressure from the higher financing costs.
In the event that corporates are unable or unwilling to refinance their debt at market prices, they may be able to repay debt from retained earnings or rely on other sources of finance such as revolving credit facilities. However, the ability of more leveraged companies to do this is likely to be limited as we estimate that while highly leveraged companies (those with debt/EBIT of greater than 4.5) account for around 60% of the debt held by private non-financial corporates, they only hold around 5% of the cash. This increases the likelihood that they take other actions like reducing investment or employment, that impact on the real economy.
This post was prepared with the help of Laura Achiro and Neha Bora.
This analysis was presented to the Financial Policy Committee in 2023 Q2.
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